Accounting For Program Services and The Activities That Support Them
Donors and funders want to know how your nonprofit uses its financial resources — maybe even more than ever during this difficult time. Rules issued by the Financial Accounting Standards Board (FASB) can help you break down spending. Here’s a review of the key rules affecting expense allocation.
And the definitions are …
According to the FASB’s Accounting Standards Codification (ASC) Not-for-Profit Entities (Topic 958), program services are activities that result in goods and services being distributed to beneficiaries, customers or members that fulfill your nonprofit’s purposes or mission. They’re its major priority.
FASB breaks down supporting activities into three categories. First is management and general services. These aren’t identifiable with a single program, fundraising activity or membership activity but are indispensable to your nonprofit’s existence. They generally include oversight and administration, budgeting, human resources and obtaining fee-based revenues.
Second is fundraising. This encompasses activities involved in soliciting contributions from individuals, foundations, government agencies and others.
Finally, membership development refers to recruiting prospective members, collecting membership dues and managing member relationships. You should state membership development separately in your financial statements if significant benefits or duties are associated with membership.
Another relevant standard
There’s another FASB document that applies to how your organization accounts for expenses: Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities.
The standard requires all nonprofits to include in their financial statements an analysis of expenses by nature (for example, salaries, rent or utilities) and function (program service, management and general, fundraising and, if significant, membership development). Your organization must present information about expenses in one location on its statement of activities, in the financial statement notes or in a separate financial statement.
Nonprofits often engage in fundraising activities that also have elements of another function. For example, a special event or direct mail campaign could include both fundraising and program components. Some organizations err by lumping all joint costs — such as salaries, consultant fees, paper and postage — into fundraising.
Under ASU 2016-14, though, you must allocate such costs between fundraising and the other function(s) if certain criteria related to purpose, audience and content are met. If those criteria aren’t satisfied, report all costs of the joint activity as fundraising.
It’s easy to regard the management and general function as a catchall, especially for expenses that seem like overhead. Some of these expenses, however, belong elsewhere. For example, the standard dictates that interest costs (such as mortgage interest on a building) be allocated to specific programs or supporting services whenever possible.
Similarly, certain costs that appear to relate to the management and general function, at first glance, benefit more than one function. For instance, IT costs can benefit management and general, fundraising and program delivery. Insurance could cover property that houses multiple functions or a single program. Allocate these costs accordingly.
Recording too much expense to management and general conversely results in underallocation to other functions. Some examples: An employee who normally works as support staff for the executive department might spend some time directly conducting or supervising program services. And the executive director may spend a significant amount of time drumming up donations. You may need to allocate their salaries and benefits among those functions. This requires the careful tracking of employee time and activities.
ASU 2016-14 requires nonprofits to disclose the method they use to allocate expenses among the functions. Guesstimates won’t cut it. Because it’s both acceptable and advisable to employ different allocation methods for different expenses, you can simplify the disclosure process by developing and adhering to a documented allocation plan.
You might opt to allocate rent, mortgage, utility and building depreciation expense based on total square footage — allocating 40% of the expense to the fundraising department that takes up 40% of square footage. Salaries should be allocated based on actual time and effort expended per function, using the time tracking methods mentioned above. Certain overhead costs can be allocated in accordance with these salary allocation percentages. Employee benefits, payroll processing, payroll taxes and IT are examples of expenses that can be allocated this way.
Many organizations have struggled with allocating expenses properly, to comply with these accounting standards. You may be able to simplify your processes to get it right. We can help.